Administration : Audit - Standards of Review
January 6, 2023
Re: § 58.1-1821 Application: Withholding Tax
Dear *****:
This will respond to your letter in which you seek correction of the withholding tax assessments issued to ***** (the “Taxpayer”), for the taxable periods January 2017 through December 2019.
FACTS
The Taxpayer was a nonprofit organization that sold life insurance and annuities to its members. It issued Form W-2s to certain full-time sales personnel it classified as both statutory employees and independent contractors. The Taxpayer also issued Form 1099s to its part-time sales staff. Some of the full-time sales personnel also received Form 1099s for the sales of insurance and financial products through two of the Taxpayer’s affiliated businesses.
The Department audited the Taxpayer for the periods January 2017 through December 2019. Based on a determination issued as to one worker who had filed a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the Internal Revenue Service (IRS), the Department concluded that all full-time sales personnel who received W-2s should have been classified as employees and had Virginia income tax withheld from their commissions. As a result, assessments were issued for withholding tax due. The Taxpayer appealed, contending the workers in question were independent contractors.
DETERMINATION
Employee Defined
Virginia Code § 58.1-460 defines “employee” as “an individual, whether a resident or a nonresident of the Commonwealth, who performs or performed any service in the Commonwealth for wages . . . .” The Code of Virginia does not define “independent contractor” for income tax withholding purposes. Under Title 23 of the Virginia Administrative Code (VAC) 10-140-10, the relationship between an employer and employee or independent contractor is determined in accordance with the test set forth in Treas. Reg. § 31.3401(c)-1. That regulation generally provides that “an employee is subject to the will and control of the employer not only as to what shall be done but how it will be done.”
In Public Document (P.D.) 21-56 (5/4/2021), the Department adopted the common-law analysis to determine whether an individual is an employee or an independent contractor. Consistent with the IRS, the Department will consider all information regarding the relationship between the worker and the business that provides evidence of the degree of control and the degree of independence that existed. See Internal Revenue Code (IRC) § 3121(d)(2) and Treas. Reg. § 31.3121(d)-1. In IRS Publication 15-A, the IRS explains that facts providing this evidence fall into three categories: behavioral control, financial control, and the type of relationship of the parties. In making such a determination, the Department will examine all evidence regarding a worker’s classification, including, but not limited to, any contracts that existed between the taxpayer and the individuals in question, and written or oral testimonials from individuals with knowledge of the relationships, including members of management or the individuals themselves. Such evidence may also include the types of documents used to evidence worker classification under the 20 factor test enumerated in Rev. Rul. 87-41.
Statutory Employee
The term “statutory employee” commonly refers to individuals in certain named occupational groups described in IRC § 3121(d)(3) who would normally be independent contractors under common law but who are employees for federal employment tax purposes under the Federal Insurance Contributions Act (FICA). See Rev. Rul. 90-93, 1990-2 CB 33. Full-time life insurance sales people who are not common law employees are expressly included as statutory employees under IRC § 3121(d)(3). Individuals who are in one of the categories listed IRC § 3121(d)(3) are statutory employees only for certain specified provisions of the IRC. They may still be independent contractors for purposes of withholding. See Rev. Rul. 90-93.
SS-8 Determinations
A Form SS-8 is a request by either a worker or business to the IRS for a determination as to whether the services the worker provides to the business are those of an employee or independent contractor. The IRS SS-8 determination in this case was issued by the IRS at the request of one of the Taxpayer’s sales personnel.
The auditor concluded that because the salesperson described in the SS-8 was determined by the IRS to be a common law employee, all of the Taxpayer’s sales personnel who were statutory employees were also common law employees subject to withholding. The Taxpayer contends that the SS-8 determination was incorrect. The Taxpayer also states that it is further contesting the IRS determination.
In addition, the Taxpayer asserts that the fact scenario presented in the SS-8 did not apply to all of its sales personnel included in the audit. Full-time sales staff were issued Form W-2s as statutory employees. Part-time sales staff were issued Form 1099s as independent contractors. The Taxpayer explains that some full-time sales personnel were transferred to part-time status and some part-time sales personnel were transferred to full-time status. In addition, it states that some of its sales staff was promoted to management, and managers were transferred back to the sales force. Further, the Taxpayer states that some personnel performed work for affiliated companies for which they would receive form 1099s.
The IRS assigns Form SS-8 requests to technicians who review the facts, apply the law, and render a decision. A formal determination is generally issued to both the payer and the worker. The SS-8 determination process is not considered an audit and the appeals rights that may be available in connection with an examination do not apply. A party that disagrees with a formal SS-8 determination, however, may seek a reconsideration with the IRS.
Further, a formal SS-8 determination applies only to the worker, or class of workers requesting it, and the decision is binding on the IRS only. While they may be informative, SS-8 determinations are not legally binding on the Department or even the business that is the subject of an SS-8 determination.
Withholding Audits
Under the provisions of Virginia Code § 58.1-205, an assessment of a tax by the Department is deemed prima facie correct. As such, the burden of proof is on the Taxpayer to show the Department’s assessment is incorrect.
The Department’s regulations, however, require an evaluation of an employer’s records to determine if its workers are employees or independent contractors pursuant to the factors enumerated in Treas. Reg. § 31.3121(d)-1 and as further described in Rev. Rul. 87-41 and, more recently, in IRS Publication 15-A. See P.D. 18-107 (6/6/2018), P.D. 20-170 (9/22/2020), P.D. 21-56, P.D. 21-81 (7/6/2021) and P.D. 22-39 (3/8/2022).
The Department’s audit staff, therefore, must give taxpayers a full opportunity to present information and evidence concerning their relationships with workers. Such evidence may take the form of written documentation, including, but not limited to, any contracts that existed between the taxpayer and the individuals in question. The evidence may also include, but again not be limited to, written or oral testimonials from individuals with knowledge of the relationships, including members of management or the individuals themselves whom the Department is trying to determine were employees or independent contractors. Once a taxpayer has had a full opportunity to present such information, the audit staff should undertake a complete evaluation of such evidence and fully document its analysis in reaching its audit conclusions.
In this case, the Department’s audit staff relied on an SS-8 determination issued by the IRS that addressed one sales person. The auditor then concluded that every sales person was an employee and issued assessments accordingly.
CONCLUSION
Because audit staff failed to evaluate the Taxpayer’s records to determine whether certain of its sales staff were employees or independent contractors, the case will be returned to the audit staff to conduct a complete examination of the relationships at issue in accordance with the procedures outlined above. The Taxpayer, in turn, must provide sufficient information to support its contention that its workers were independent contractors during the tax periods at issue. In particular, the Taxpayer and the audit staff should review IRS Publication 15-A for a discussion of the different categories of factors at issue.
Once the examination is completed, the audit staff is directed to prepare a revised audit report and communicate the result of the examination to the Taxpayer in writing. The report should fully analyze any information the Taxpayer is able to provide concerning the factors described above. Should the Taxpayer wish to appeal the result of the revised audit, it will have 90 days from the date the audit staff communicates the audit result in writing in which to appeal.
The Code of Virginia sections, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/4056.B